Debt Crisis Solutions are Leaving Investors Behind

It used to be taken for granted that you could put aside some money and earn
enough interest to be better off than when you started.

As the world continues to struggle with the aftermath of an enormous credit
boom and its subsequent bust, though, this kind of objective seems hopelessly
naïve. Events in Europe and the US this week are the latest reminder of
this. To see why, let's start with a riddle:

If I owe you €10,000, and the amount of money I have is zero, is it possible
to let me off the hook without you taking a loss?

The question is rather silly, yet it is analogous to the one facing policymakers
in Europe right now as they decide what to do about Greece.

Here's the problem in a nutshell: Greece was tasked with reducing its debt-to-GDP
ratio to a 'sustainable' 120% by 2020 (by complete coincidence the ratio for
the Eurozone's biggest debtor Italy at the time the target was set last year).
That wasn't not enough time, Euro politicians decided last week, so they extended
the deadline to 2022.

Christine Lagarde, managing director at the International Monetary Fund, was
not happy about this. She would rather see the deadline stay as 2020,
with the debt being reduced directly by further write downs. Germany and
other Euro members are averse to this since it would impose further losses
on creditors. Private sector Greek bondholders were burned back in February,
compelled to take losses as part of a restructuring deal.

A further write down might also hit the European Central Bank, which has already
agreed to forego profits on its Greek bonds. If the ECB takes actual losses,
would this not amount to central bank financing of government debt - something
prohibited by European treaty? According to Germany, it would.

So we have a problem where a debtor cannot pay and creditors don't want to
take a hit (and in the case of the ECB may not legally do so, many argue).
Naturally the first maneuver is to give the debtor a bit more time, which is
exactly what Eurozone politicians did last week.

This will only achieve so much though. The latest figures show the Greek economy
is still contracting; policymakers will have to buy an awful lot of time if
Greece is to pay down the debt through economic growth alone.

So what else can be done? This is where the people at the top are yet to reach
agreement. One of the suggestions doing the rounds is to lower the interest
rate Greece pays on its bailout loans, a classic move to lower the real, inflation-adjusted
value of debt.

Just ask Ben Bernanke. In a speech given
this week the Federal Reserve chairman reiterated the need to maintain loose
monetary policy for the foreseeable future.

"A highly accommodative stance of monetary policy will remain appropriate
for a considerable time after the economic recovery strengthens," he said.

Bernanke also repeated his call for US lawmakers to sort out the deficit,
arguing that monetary policy can only provide a supportive environment; it
cannot solve fiscal problems. Not the Bernanke is a deficit hawk:

"Even as fiscal policymakers address the urgent issue of longer-run fiscal
sustainability," Bernanke said, "they should not ignore a second key objective:
to avoid unnecessarily adding to the headwinds that are already holding back
the economic recovery."

In other words, the US government should maintain borrowing near record levels,
while also trying to get borrowing onto that sustainable path.

"Fortunately, the two objectives are fully compatible and mutually reinforcing.
Preventing a sudden and severe contraction in fiscal policy early next year
will support the transition of the economy back to full employment; a stronger
economy will in turn reduce the deficit and contribute to achieving long-term
fiscal sustainability. At the same time, a credible plan to put the federal
budget on a path that will be sustainable in the long run could help keep
longer-term interest rates low and boost household and business confidence,
thereby supporting economic growth today."

He may be proven right. But whether he is or not, that "accommodative" policy
of below-inflation interest rates is here to stay.

That should give continued support to the gold
price. The chart below is from a presentation by
Charlie Morris, head of global asset management at HSBC, given at last week's
London Bullion Market Association annual conference:

Morris points out that when the annual real rate of interest (i.e. how much
you make adjusted for inflation) has been below 2%, gold has tended to do well:

Many investors today would be happy with a real return of flat zero - at least
they wouldn't be losing ground.

As the world grapples with the plight of sovereign debtors, though, the idea
of getting a reliable real return from an investment is sadly starting to seem
rather out-of-date. Moody's downgraded France this week; here's one of the
reasons it gave in its ratings
rationale:

"...unlike other non-euro area sovereigns that carry similarly high ratings,
France does not have access to a national central bank for the financing
of its debt in the event of a market disruption."

In other words, if France could just print what it owes, it could probably
still be rated triple-A. Creditors would get back the money they lent out,
and there would only be the small matter of it being worth a lot less than
when they lent it.

That is today's reality. It may be unavoidable given the sheer size of the
debt problems affecting much of the globe; but it's a pretty raw deal for those
trying to grow or even hang onto the value of their savings.

Editor of Gold News, the analysis
and investment research site from world-leading gold ownership service BullionVault,
Ben Traynor was formerly editor of the Fleet Street Letter, the UK's
longest-running investment letter. A Cambridge economics graduate, he is a
professional writer and editor with a specialist interest in monetary economics.

Please Note: This article is to inform your thinking, not lead it.
Only you can decide the best place for your money, and any decision you make
will put your money at risk. Information or data included here may have already
been overtaken by events - and must be verified elsewhere - should you choose
to act on it.